David Laws: let’s cut taxes and spending. For once, I’m unconvinced. Here’s why…

by Stephen Tall on June 24, 2012

David Laws has earned himself a generous write-up in today’s Telegraph, with the paper which triggered his resignation from the cabinet two years ago hailing his ‘radical vision of a liberal state’, and lamenting with crocodile tears that his downfall was ‘a great loss to the Cabinet’.

The cause is an interview David has given to the paper in which he makes the case for further public spending cuts and lower taxes — a case he has outlined in greater depth in an article in the current Institute of Economic Affairs journal, highlighted last week on LibDemVoice. Here’s an excerpt from the interview:

In his paper, Mr Laws argues that the great names of Liberalism – William Gladstone, David Lloyd-George, Adam Smith and John Maynard Keynes – would be “shocked” that more than 40% of the economy is now accounted for by the public sector. “We are going to have to see a shrinking of the state share of the economy until it is back into kilter with the amount of tax people are prepared to be pay,” he says. Only health, education and pension spending can be protected from this, he argues. All other areas of state spending should fall.

It’s an agenda that will be music to the ears of many Tories, but many Lib Dems will surely be appalled by idea of one of their senior figures calling for years more of cuts. “Future UK governments should consider a further substantial rise in the personal tax allowance, along with lower marginal tax rates of tax at all income levels,” he writes in the IEA article. “The implication of the state spending 40% of national income is that there is likely to be too much resource misallocation and too much waste and inefficiency.”

I’m a big fan of David’s: he’s one of the most intellectually curious politicians I’ve met, much more interested in asking questions than he is in rehearsing out-loud his own views. But his argument here isn’t the strongest he’s mounted. While I’m sure our liberal forebears would be ‘shocked’ at the growth of state spending, there are many other aspects of modern life — cultural, scientific, technological — that would also perturb them. It’s not an argument in and of itself.

There are three other points I would make on reducing state spending to 35% of GDP. First, I think if such figures are to have any traction they need to be backed up by concrete example of the cuts that would be implemented. Abstract ‘size and shape’ discussions do not progress us far. David cites innovative revenue-generation in the public sector as one source of new income, but I’m unconvinced that’s gets us very far towards ‘the magic 35%’.

Secondly, there is only weak correlation — and very little evidence of causation — between lower public spending and taxes and economic performance. This graph from the Financial Times, accompanying an article by Martin Wolf, makes the point that there are low-taxing low-productive countries, and high-taxing high-productive countries:

Martin’s conclusion from this evidence is an important one:

The conclusion to be drawn is that a tax burden within the range of 30 per cent to 55 per cent of GDP) tells one nothing about a country’s economic performance. It is far more a reflection of different social preferences about the role of the state. What matters far more are culture, quality of institutions, including law, levels of education, quality of businesses, openness to trade, strength of competition and so forth.

Thirdly, before he became Vince Cable’s special advisor, Giles Wilkes produced an excellent post in January 2010 deconstructing why the correlation is weaker than commonly supposed. I recommend reading it all, but his conclusion bears emphasising:

… all the hysterics worrying about how large the state has become in the last two years, are misusing one metric – the spending/GDP ratio – to present a false picture of how much of what we do is actually state-determined. Let’s be serious: spending on this naive measure jumped from ~39% to %48% in a matter of 4 years. Did this mean the government suddenly ‘taking over’ 10% of the economy’s production decisions? Of course not! The absolute volume of government-economy transactions probably grew a little, and the volume of private-private transactions probably fell a little. If the government had bought Tescos (£47bn annual sales worldwide – 3% of UK GDP) and started running it like a Quango, we would have had a hit to our productivity. But that is not what happened.

The interesting ratio would be that between the number of transactions involving the State and £60,000bn. I have no earthly clue what that is, except for “much much less than 50%”.

Does this mean the Left does not need to worry about Big government damaging economic growth? No, of course not. For a start, the State can damage the economy through pure regulation, by for example dictating what everyone should be paid … It can also damage at the margin. A single state supermarket might damage all the grocery market by undercutting unfairly. Its methods of redistribution also matter: taxes on rents are better than those on economic activity. But simply parroting the public spending/GDP ratio achieve very little indeed.

We should not as a society tax more than we need to, nor spend more than we want to. Much political debate turns on where those boundaries lie, and we should be honest and up-front with people where the spending cuts would fall, and what the tax rewards would be. What we shouldn’t do is conflate that legitimate argument with the automatic assumption that economic output and productivity is reliant on one simple lever to be pulled or released at will.

* Stephen Tall is Co-Editor of Liberal Democrat Voice, and also writes at his own site, The Collected Stephen Tall.